Chemical Ind

New York Mr. Peter Wilkes Managing Director +1 212 421 2000 ext. 216 [email protected]

Toronto Ms. Susan McGeachie Director +1 905 707 0876 ext. 217 [email protected]

San Francisco Mr. Pierre Trevet Managing Director +1 415 332 3506 [email protected]

Tokyo Mr. Hiromichi Soma Director +81 3 5976 8337 [email protected]

Paris Perrine Dutronc Managing Director +33 (0)1 44 54 04 89 [email protected]

London Mr. Andy White Managing Director +44 (0) 20 7073 0469 [email protected]

Sydney Mr. Bill Hartnett Managing Director +61 2 9940 2688 [email protected]

Innovest Uncovering Hidden Value for Strategic Investors www.innovestgroup.com

Overview of the Chemicals Industry Overview for Coming Clean

March 2007

Report prepared by: Innovest Strategic Value Advisors, Inc., a New York-based investment research firm with more than ten years of investment research experience and a dedicated chemicals sector team.

KEY ISSUES

Lost businesss in the US Currently the US remains the major production center for the industry. However over the past five years companies have begun moving operations to Asia, India and the Middle East and will continue to do so for the forseeable future.

REACH While Innovest has developed a comprehensive analytical approach to determine individual company exposure to the regulation, the bottom line is that most large cap firms are not expected to experience dramatic affects.

Commodity Firms: Business As Usual Commodity chemicals production remains a marginal business meaning that innovation is limited and negative externalities associated with production continue to be an issue. Meanwhile more specialized firms in the Diversified and Specialty segments of the industry are turning to new technological capabilities that may yield safer synthesis and better chemistry over the long term.

No part of this report may be reproduced in any manner without the written permission of Innovest Strategic Value Advisors, Inc. The information herein has been obtained from sources which we believe to be reliable, but we do not guarantee its accuracy or completeness. All opinions expressed herein are subject to change without notice. Innovest Strategic Value Advisors, Inc., its affiliated companies, or their respective shareholders, directors, officers and/or employees, may have a position in the securities discussed herein. The securities mentioned in this document may not be eligible for sale in some states or countries, nor suitable for all types of investors; their value and the income they produce may fluctuate and/or be adversely affected by exchange rates. 2005 Innovest Strategic Value Advisors, Inc. All rights reserved.

Innovest Strategic Value Advisors Chemicals Industry Overview www.innovestgroup.com March 2007

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Table of Contents

Chapters

1 Executive Summary.............................................................................................6

2 The Chemical Industry ........................................................................................8 Definitions & Categories ........................................................................................8 Organic Chemicals ................................................................................................9 Inorganic Chemicals ............................................................................................10 Market Based Categories ....................................................................................11 Notes on Sector Definitions .................................................................................27

3 Global Market and Production..........................................................................28 Regional Trends in Chemical Production ............................................................32 Profits ..................................................................................................................39 Manufacturing......................................................................................................41 Construction ........................................................................................................41 Automobiles .........................................................................................................41 Forces for Change in the Industry: ......................................................................41

4 The Corporations ...............................................................................................50 Clean Tech Development, Capturing Future Value............................................54 Biobased Plastic ..................................................................................................60 Ethanol and Bio-fuels ..........................................................................................63 Environmental Catalysts ......................................................................................66 REACH ................................................................................................................67 Analysis of REACH..............................................................................................73

5 End Users ...........................................................................................................77 Commodity Chemicals.........................................................................................80 Specialty Chemicals ............................................................................................83 Specialty chemical end user markets: .................................................................83

6 Innovest Suggestions for NGO Focus.............................................................92 Climate Change...................................................................................................92 Emerging Markets................................................................................................93 Health & Safety....................................................................................................93 Toxic Waste .........................................................................................................95


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Site Security issues .............................................................................................98 Product Liability and Regulation ..........................................................................99

6 Appendices.......................................................................................................109

Figures

FIGURE 1 US Business of Chemistry Flow Chart 2005 (billions).......................8 FIGURE 2 Chemical Sector Value Chain ...........................................................9 FIGURE 3 Chlor-Alkali Chain ...........................................................................14 FIGURE 4 Ammonia Chain...............................................................................15 FIGURE 5 Methanol Chain ...............................................................................16 FIGURE 6 Ethylene Chain (Ethylene is the most important basic chemical) ...17 FIGURE 7 Propylene Chain..............................................................................18 FIGURE 8 C-4 Chain ........................................................................................19 FIGURE 9 Benzene Chain................................................................................20 FIGURE 10 Toluene Chain.................................................................................21 FIGURE 11 Xylene Chain...................................................................................22 FIGURE 12 International Classification Codes...................................................26 FIGURE 13 US Industrial Production according to chemical type (index where 2002 = 100). ................................................... ..26 FIGURE 14 Global Chemical Sales (billions of dollars) 2005.............................28 FIGURE 15 Global Chemical Shipments, By Region Origin/Export 2005 ..........29 FIGURE 15 Global Chemical Shipments, By Region Origin/Export 2005 ..........29 FIGURE 16 Global Chemical Shipments by Industry .........................................30 FIGURE 17 Size of Regional Business of Chemistry .........................................30 FIGURE 18 US Direct Investment Abroad (USDIA) and Foreign Direct Investment in the US (FDIUS) in the business of chemistry ($ million) ......................32 FIGURE 19 Capacity Utilization in the Business of Chemistry (% of capacity) ..33 FIGURE 20 Lost Manufacturing in the United States .........................................34 FIGURE 21 Percentage of Production Assets in Emerging Markets Global Chemicals Sector 2005/06 .........................................................................................35 FIGURE 22 US Business of Chemistry, 2005 ($ billions) ...................................40 FIGURE 23 Global Chemicals Market Segmentation: % Share by Value, 2004 40 FIGURE 24 Energy Performance of Select Companies, 2005 ...........................43 FIGURE 25 Patents Granted by Segment and Nation .......................................48


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FIGURE 26 Basic and Specialty Chemical Revenues from New Products (as % of Revenues) ESTIMATED.........................................................................................49 FIGURE 27 Global Top 50 Chemical Companies, 2006 ....................................51 FIGURE 28 Scores for Environmental Products Strategy and Development .....58 FIGURE 29 Application by Industry Segment.....................................................61 FIGURE 30 Companies in the Plastics Value Chain ..........................................62 FIGURE 31 REACH Registration Process .........................................................68 FIGURE 32 European sales as a Percent of Total Revenues in 2004 ...............72 FIGURE 33 Estimated Exposure to REACH ......................................................73 FIGURE 34 Basic analysis of European sales and production assets in Europe 74 FIGURE 35 Sample Analysis REACH Product Survey ......................................76 FIGURE 36 US Chemistry Sales by Industry (million $) .....................................77 FIGURE 37 Value of Chemistry as a % of All Materials-Consumer Goods........78 FIGURE 38 Value of Chemistry as a % of All Materials-Industrial/Business Goods 79 FIGURE 39 ChemFactors for Packaging (Value of Chemistry as a % of All Materials) 80 FIGURE 40 US Bulk Petrochemical production, 2005........................................81 FIGURE 41 Petrochemical Derivatives and Other Industrial Chemicals US Business Value and Major Industrial End Markets .....................................................81 FIGURE 42 US Plastic resins production, value, end users............................82 FIGURE 43 US Synthetic Fiber production ........................................................82 FIGURE 44 US Shipments of Specialty Chemicals: ...........................................83 FIGURE 45 Largest North American Ethylene Producers, 2004........................86 FIGURE 46 Global demand for ethylene ............................................................86 FIGURE 47 Select companies that serve the PVC Value Chain ........................88 FIGURE 48 PVC price per ton in Asia and the US .............................................89 FIGURE 49 Net property, Plant & Equipment per Employee by US Industry ($ thousand).........................................................................................................90 FIGURE 50 Motivation for Capitol Investment in the US Business of Chemistry (% of total spending)...................................................................................................90 FIGURE 51 US Basic and Specialty Chemical Producers EH&S Spending......91 FIGURE 52 EH&S Spending by Basic & Specialty Chemical Producers by Type of Spending. ........................................................................................................91 FIGURE 53 Chemical Industry releases and transfers.......................................96 FIGURE 54 The following is a ranking of the sector by RSEI score: ..................97 FIGURE 55 Assessment of Risk and Strategic Positioning for 15 Firms Selected for the Innovest Index........................................................................................104


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FIGURE 56 20 Year Timeline for Technological Development ........................107 FIGURE 57 Top 100 Chemicals by Volume .....................................................109 FIGURE 58 Toxic Chemicals Released in the Largest Quantities....................111


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1 Executive Summary

The global chemical industry has sales estimated at $2.5 trillion dollars and the sector is experiencing an unprecedented period of mergers and positive earnings reports. That stated, new issues such as energy security, changing consumer preferences and the forces of globalization create new challenges for the global chemicals sector. This report outlines many of these industry driving forces so that NGOs can better understand how to strategize around them.

The economic climate for the sector is tepid in the nearterm but there are positives. The industry generates 2% of the United States GDP but is rapidly expanding overseas. Declines in housing starts and a potential overall slump in the economy are predicted to cause a slight reduction in demand but not an abrupt downturn. Chemical sector end markets such as textiles, packaging and electronics and other goods are experiencing growth giving new life to many companies in the chemical sector.

To date, the United States continues to dominate global chemicals production by volume. Given this, it is relevant to note that the newly elected Democratic majority in Congress is looking into a variety of initiatives from greenhouse gas emissions control to chemical site security regulation.

However it is increasingly obvious that the migration of production capacity overseas is resulting in a loss of chemicals production activity in the US. In 2004 the industry lost approximately US $47 million and about $53 million worth of production in 2005. The largest losses by end market appear to be in chemicals for the textiles, electronics and mining sectors1.The emphasis in our analysis is on China as it currently represents the most important impetus for overseas migration of chemicals production deals although new production is also moving to India and the Middle East.

This has implications for companies and for the way that the externalities of chemicals production are perceived and dealt with globally. The current operating climate is rapidly changing for chemicals production in China. Innovest tracks how this changes the operating expense outlook in the region. However, for the NGO community. it is the age old concern that regulation and enforcement remain less rigorous in many parts of the world where chemicals production is slated to increase. The reality on the ground is never what is portrayed in corporate responsibility

1 US Department of Commerce, American Chemistry Council. Guide to the Business of Chemistry 2006. Pg 72.


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disclosure. The recent airing of China from the Inside on US public television provides visual evidence of this2.

Raw material prices are undoubtedly one of the most critical driving forces for the sector and largely determine where new production arises. Preliminary Innovest analysis shows a potential underestimation of global natural gas supply. This has grave implications for chemicals producers unless new energy resources can be accessed by the sector. Calls are being made for greater funding of coal gasification projects. Additionally, pending regulatory scenarios in the US may have a de facto affect on the price of energy drawn from the grid. The chemicals sector will invariably be the first hit by such changes.

Finally, product portfolios are rapidly changing to adjust to new demand scenarios. Companies, desperate for new marketing platforms are recognizing for the first time that green product design principals may help top and bottom line growth. More importantly, the sector is already in full swing in the race to meet demand for alternative and renewable energy technologies. We project that these trends will gradually change the face of the chemicals sector, particularly as new technologies at the quantum scale enable increasingly cleaner modes of production and which may yield fundamentally safer products over the very long-term.

Within this context NGOs can plan their interactions with the sector to speed change. Ultimately, the research process for this report yielded two important observations for activists targeting the chemicals industry. First, while many of the large specialized companies are introducing new technological capabilities that promise to change the future of chemical synthesis for the better, the old line Commodity companies continue to produce the same basic chemicals using dated production options designed to get product to market in the least expensive and in a rapid manner. The externalities associated with this group of companies may continue to be a focus for NGOs.

Secondly, as companies increasingly turn to high performance catalysis, renewable energy technology, white biotech and other next generation technological platforms, there appears to be a distinction between new chemistry and old chemistry. the challenge for NGOs is to target old chemistries and identify the companies making them. If viable alternatives are available, the market for such products will eventually drop out.

The final section of the report is an overview of key environmental and social issues that Innovest feels are pertinent to the performance of companies in the sector.

2 http://www.pbs.org/kqed/chinainside/


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2 The Chemical Industry

Definitions & Categories With its essential role in other sectors, it is not surprising that the chemical sector is a vast, complex industry. Companies that produce chemicals are intricately tied to one another as suppliers and consumers, and are dependent upon other industries, as well as global economic trends.

FIGURE 1 US Business of Chemistry Flow Chart 2005 (billions)

Source: Bureau of Economic Analysis, American Chemistry Council (ACC) analysis

The main raw materials of the chemical industry are fossil fuel, water, air, salt, limestone, sulfur, and other specialized raw materials. The industry converts these materials into products; a chief characteristic of the industry is that its products almost always require further processing before reaching end users.

Given the complexity of the industry, there are several ways in which the industry is commonly broken down into sub-sectors and categories. These categories, however, are not necessarily fixed. Furthermore, major chemical-intensive segments such as pharmaceuticals and agrichemicals are sometimes considered sub-sectors of the industry and sometimes categorized as distinct end-market sectors. In the financial community, it is typically noted whether pharmaceutical data is included in analysis.

$202.4 Consumers & Other Demand

$44.8 Rubber & Plastics Products

$31.3 Health Care

$16.6 Agriculture

$14.3 Construction

$10.1 Paper Products

$8.5 Semiconductors & Electronic Components

$8.0 Textiles & Fabrics

$6.6 Textile Mill Products

- Imports ($119.5)

+ Exports ($128.3)

Final Sales

$435.1

Intra-industry Sales

$131.9

Shipments

$558

- Imports ($119.5)

+ Exports ($128.3)

Final Sales

$435.1

Intra-industry Sales

$131.9

Shipments

$558

$6.5 Motor Vehicles & Parts

$4.9 Food Products

$4.8 Fabricated Metal Products

$4.7 Wholesale & Retail Trade

$4.3 Mining

$4.2 Petroleum Products

$2.6 Personal Services

$59.5 All other industries


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[For the purpose of this report, pharmaceuticals and agri-chemicals are considered separate end-market sectors, unless otherwise noted.]

FIGURE 2 Chemical Sector Value Chain

Commodity Diversified Specialty Pharmaceuticals Other End users Agrichemicals Source: Innovest

On a basic level, a distinction is made according to the types of chemicals produced. Major categories include organic chemicals and inorganic chemicals, as well as commodity, diversified, and specialty chemicals.

ORGANIC CHEMICALS

Simply defined, organic chemicals contain carbon. More than 90% of all known compounds are organic, and include chemicals found in animal and plant life. Organic chemicals are mostly derived from substances such as petroleum, coal, and natural gas. Examples of organic chemicals include benzene, ethylene, formaldehyde, phthalate plasticizers, urea, vinyl acetate, and vinyl chloride.

The organic chemical industry is highly diverse and includes thousands of individual chemicals and compounds. Companies take a few basic raw chemicals and combine and transform them into new substances that are, in turn, valuable to other industries. Organic chemicals are essential ingredients in plastics, synthetic fibers, rubber, adhesives, inks, dyes, explosives, and fertilizers.


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Petroleum-based chemicals (petrochemicals) account for a large majority of organic chemicals. Approximately 95% of organic chemicals are derived from petroleum or natural gas3. These chemicals are produced by transforming petroleum or natural gas into more useful petrochemical "building blocks" (such as benzene, toluene, xylene, ethylene, and propylene) and then into tens of thousands of intermediate chemicals. Petrochemical Derivatives is a $102 Billion Business in the US according the American Chemistry Council.

For petrochemicals, there are several methods of separating, or cracking the large hydrocarbon chains found in fossil fuels. Natural gas is processed to produce methane and natural gas liquids (NGLs), and petroleum is refined to produce a variety of products including naphtha and NGLs. Naphtha and NGLs and processed in large vessels or crackers, which are heated and pressurized to crack the hydrocarbon chains into smaller ones. These smaller hydrocarbons are the petrochemical feedstocks used to make other chemical products.

Ethylene is the largest petrochemical product by volume, and is used in the production of plastic, rubber, fibers, detergents, solvents, and anesthetics. Issues associated with petrochemicals manufacture include: high intensity energy use, petrochemical processes involve volatile processes, petroleum based plastics are less optimal from a raw material sustainability perspective, and some petrochemicals fall into toxicity classifications such as benzene.

Major companies include BASF, Dow Chemical, Du Pont, ExxonMobil Chemical Company, Royal Dutch/Shell Group

INORGANIC CHEMICALS

Inorganic chemicals do not contain carbon-carbon bonds, (Though some inorganic compounds may contain carbon, they lack carbon-carbon bonds). Inorganic compounds are generally derived from metal and non-metallic minerals. Examples of inorganic chemicals include acids, metals, and gases; nitrates, fluoride, metals, silicones, silanes, and borates; aluminum sulfate, ammonia, chlorine, caustic soda, hydrochloric acid, hydrogen peroxide, nitric acid, sodium chlorate, and sulfuric acid.

The inorganic chemical industry deals with inanimate material and processes to create chemicals and gases that are often referred to as basic chemicals. The industry's products are used as basic chemicals for industrial processes (i.e., acids, alkalies, salts, oxidizing agents, industrial gases, and halogens); chemical products to be used in manufacturing products (i.e., pigments, dry colors, and alkali metals); and

3 United States Environmental Protection Agency. EPA Sector Notebook. Organic Chemicals. 1996. page 5-9


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finished products for ultimate consumption (i.e., mineral fertilizers, glass, and construction materials).

The largest use of inorganic chemicals is as processing aids in the manufacture of chemical and nonchemical products. Consequently, inorganic chemicals often do not appear in the final products.4 Inorganic chemicals account for nearly a quarter of total global sales. Most inorganic chemicals are used as building blocks for other compounds and products; the industry is therefore closely tied to business cycles of other manufacturing industries, as well as the state of the global economy.

Analysis: While organic chemicals also have their place in the Toxic Release Inventory, a focus of Innovest research has been on the inorganic sector, namely the chlor-alkali segment. See section 3 Products for further information.

Major companies include Dow, El Dupont de Nemours, Degussa, Celanese, FMC, LAir Liquide, BOC Group.

MARKET BASED CATEGORIES

Chemicals, and the companies that produce them, are also categorized according to the market segments they serve. . These are the categories used by the financial community and also by Innovest. This allows for company comparison across an array of factors. While these definitions have to be somewhat loose, these categories at least allow for some uniformity within groupings. For example, it is more rational to compare absolute toxic release information for companies that have relatively similar industrial processes.

Commodity Chemicals

The commodity chemicals market includes companies that manufacture basic chemicals in large volumes. These include plastics, synthetic fibers, films, certain paints and pigments, explosives, and petrochemicals. There is no product differentiation within the sector; products are sold for their composition.

The global commodity market is valued at approximately $908 billion, and is considered a mature industry. The leading revenue source is the plastics and synthetic rubber sector, followed by the petrochemical sector. Regionally, the largest global commodity market is in Asia-Pacific, which generates approximately 33% of

4 EPA Sector Notebook. Office of Compliance Sector Notebook Project. Profile of the Inorganic Chemicals Industry.. Office of Compliance Enforcement and Assurance. United Stated Environmental Protection Agency. September 1995. Page 5.


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global value. Europe follows at 31%, and the US at 22% of global market segmentation.

The commodities market is highly fragmented. The leading companies, Dow Chemical and BASF, account for less than 5% of the total market each. Other industry leaders include Bayer, Dupont, and Akzo Nobel. More than 85% of the market share, however, is accounted for by a mix of other companies. A full environmental and social rating accompanies each company on the following list. Contact Heather Langsner at [email protected] for further information.

Commodity Firms Innovest Ratings Universe 3405-TO Kuraray Company Limited 3401-TO Teijin Limited 3407-TO Asahi Kasei Corp. CZZ-FF Celanese AG NCX Nova Corp. 3404-TO Mitsubishi Rayon Company Limited 3402-TO Toray Industries Inc 4183-TO Mitsui Chemicals 4061-TO Denki Kagaku Kogyo KK 4042-TO Tosoh Corporation 4010-TO Mitsubishi Chemical Corporation 4118-TO Kaneka Corporation SOLB-BT Solvay LYO-N Lyondell Chemical Co. MGT-FF MG Technologies AG

Financial considerations for the commodity market include high energy costs, rising feedstock (raw material) costs, and the global economic situation. Intangible value considerations include operational risks such as worker protection, the environmental impact of energy use, and site security.

End user markets include other basic chemicals, specialties, and other chemical products; manufactured goods such as textiles, automobiles, appliances, and furniture; and pulp and paper processing, oil refining, aluminum processing, and other manufacturing processes. Markets also include some non-manufacturing industries.

In 2005, US shipments of commodity chemicals was valued at $198,500 million [almost $2 billion].


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Breakdown of Commodity Chemicals INORGANIC CHEMICALS

Chlor-Alkalies

Industrial Gases

Other Inorganic Chemicals

BULK PETROCHEMICALS

& INTERMEDIATES

Olefins:

Ethylene

Propylene

Butadiene

Aromatics:

Benzene

Toluene

Xylenes

Methanol

PETROCHEMICAL DERIVATIVES

& OTHER INDUSTRIAL CHEMICALS

Plastic Resins

Synthetic Rubber

Synthetic Fibers

Other Basic Chemicals:

Carbon Black

Colorants

Wood Chemicals

Printing ink


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Key Chemical Chains in Commodities/Basic Chemicals Production

FIGURE 3 Chlor-Alkali Chain

Source: American Chemistry Council

Chlorine

Chlor-Alkali Plant

Caustic Soda

Miscellaneous

Methyl Chloride, Methylene Chloride, Chloroform, Carbon

Tetrachloride, & other Chlorinated Methanes

Ethylene Dichloride

Ethylene Dichloride, & Other Chlorinated

Ethanes

Chlorinated Benzene

Dyes, Pesticides

Epichlorohydrin

Food, Toothpaste, Cosmetics

Other Chemicals

Epoxy Resins

Miscellaneous

Glycerin

Solvents

PVC Resins

Other Chemicals

Pulp and Paper

Oil Refining

Soaps, Detergents, Cleaners

Waste Treatment

Miscellaneous

Coatings, Adhesives

Printed Circuit Boards

Dry Cleaning, Metal Boards,

Degreasing

Siding, Flooring, Shower

Curtains, Pipe

Vinyl Chloride

Polyvinyl Chloride Resins (PVC)

Miscellaneous

Siding, Piping,

Flooring,

Solvents, Polymers, Metal Cleaning, Electronics

Pulp Bleaching

Water Treatment


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FIGURE 4 Ammonia Chain



16

FIGURE 5 Methanol Chain



17

FIGURE 6 Ethylene Chain (Ethylene is the most important basic chemical)



18

FIGURE 7 Propylene Chain



19

FIGURE 8 C-4 Chain



20

FIGURE 9 Benzene Chain



21

FIGURE 10 Toluene Chain



22

FIGURE 11 Xylene Chain



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Diversified Chemicals

The diversified chemicals market is comprised of companies that produce a diverse range of chemical products. These companies are characterized by a conglomerate business model, and are highly impacted by economic market cycles. Vertical integration is common throughout the group. The lead source of revenue in this sector is base chemicals.

Leading companies include BASF, Dow, Bayer, Du Pont, and Akzo Nobel.

Intangible value issues include operational risks such as worker protection, energy use, and site security. Other sustainability issues, such as environmental regulations and product liability, are emerging as relevant to long-term valuation.

The list of Diversified Chemicals Companies differs depending on the index in question and in all cases the full list is very long. The graphic below is a list of large capitalization Diversified companies rated by Innovest. Each company in the list is backed by a full environmental and social rating. For further information please contact Heather Langsner at [email protected] for copies of profiles.

Diversified Firms Innovest Ratings Universe BAS-FF BASF BAY-FF Bayer 4208-TO UBE Industries AKZA-AE Akzo Nobel 4005-TO Sumitomo Chemical Company Limited 4021-TO Nissan Chemical Industries Limited 4004-TO Showa Denko KK DOW Dow Chemicals Company DD Du Pont EI De Nemours PPG PPG Industries Inc 4182-TO Mitsubishi Gas Chemical Company Inc ORI-AU Orica Limited EMN Eastman Chemicals Company HUN-N Huntsman Corp. 4188-TO Mitsubishi Chemical Holdings Corp. EC Engelhard Corp. DGX-FF Degussa AG FMC FMC HPC Hercules Inc 4028-TO Ishihara Sangyo Limited SIK-EB SIKA Finanz


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Specialty Chemicals

The specialty chemicals market is characterized by high value-added, low volume chemical production. These chemicals are used in a wide variety of products, including fine chemicals, additives, advanced polymers, adhesives, sealants and specialty paints, pigments, and coatings.

The global specialty chemicals market generated total revenues of $577.2 billion in 2005. The leading revenue source for the market is the sale of chemicals for paints and inks, followed by fine chemicals. Europe is the largest specialty chemicals market, generating approximately 35% of global market revenue. Asia-Pacific is an important contributor to the specialty market, and is expected to grow in the future.

The specialty market is extremely fragmented. Consolidation of companies has been a major trend, and is expected to continue. Leading companies include Ciba, Rohm & Haas, Clariant, Shin-Etsu, though together they account for just 5% of global sales.

Within the specialty chemical sector, a companys strength is largely based upon intellectual property and R&D capabilities. Development of new products is crucial, and a constantly updated portfolio of patents is important for maintaining high prices.

Similar to the commodity sector, the specialty sector is affected by high costs of energy and feedstock. Intangible value issues include heightened emphasis on research, customer migration to alternative products, and the impact of regulations on products.

In addition to these market oriented distinctions, the chemical industry is comprised of several major sub-sectors. [In this report, these categories are noted when necessary.]

Subsectors and Other Distinctions Petrochemicals: Petrochemicals are derived from crude oil, crude products, or natural gas. Petrochemicals are used in the manufacture of numerous products such as synthetic rubber, synthetic fibers (e.g., nylon and polyester), plastics, fertilizers, paints, detergents, and pesticides. It is the basis for most organic chemistry.

Pharmaceuticals: Pharmaceuticals are generally considered a sub-sector of the chemical industry. Information and statistics on the chemical industry may or may not include the pharmaceutical sector, though it tends to be demarcated as a separate category.

Bio-based Chemicals: Bio-based chemicals are products, other than food and feed, that are derived from biomass feedstock. These include green chemicals, renewable plastics, natural fibers, and natural structural materials. Many of these products can replace products and materials traditionally derived from petrochemicals.


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Agricultural Chemicals: Total agricultural chemicals sales reached $26,923 million in 2005 and conventional crop protection chemicals reached $12,242 million in 2005. Global shipments of agrichemicals totaled 131.2 billion in 2005. A full environmental and social rating accompanies each company on the following list. Contact Heather Langsner at [email protected] for further information.

Specialty Firms Innovest Ratings Universe NZYM'B-KO Novozymes GIVN-EB Givaudan N ECL Ecolab Inc 4217-TO Hitachi Chemical Company Limited ROH Rohm & Haas Company CIBN-EB Ciba Specialty Chemicals 6988-TO Nitto Denko Corp. BOC-LN BOC Group PLC AI-FR Air Liquide R PX Praxair Inc APD Air Products & Chemicals Inc CLN-EB Clariant BVIT-LN British Vita PLC ICI-LN Imperial Chemical Industries PLC LONN1-EB Lonza Group DSM-AE DSM NV 4202-TO Daicel Chemical Industries Limited 4631-TO Dainippon Ink & Chemicals POT-T Potash Sask Inc AGU-T Agrium Inc 4613-TO KANSAI PAINT CO 4185-TO JSR Corp. YAR-OS YARA INTERNATIONAL 4205-TO NIPPON ZEON CO SIAL Sigma Aldrich Corp. 4063-TO Shin-Etsu Chemical Company Limited IFF International Flavours & Fragrances SYNN-EB Syngenta AG 4091-TO TAIYO NIPPON SANSO CORP MON Monsanto Company CEM Chemtura Chemical MX-T Methanex 4043-TO TOKUYAMA CORP ARJ Arch Chemicals Inc CRDA-LN Croda International PLC ELM-LN Elementis GRA Grace WR & Company Del SDF-FF K+S AG 4272-TO Nippon Kayaku Company Limited


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4114-TO Nippon Shokubai Company Limited 4203-TO Sumitomo Bakelite Company Limited YULC-LN Yule Catto & Company PLC

There are various international categories and codes to track economic and industry data. Relevant codes for the chemical sector include:

FIGURE 12 International Classification Codes

Classification System Industry Code Sub-sectors

North America North America Industry Classification System (NAICS)

NAICS 325 Chemical Manufacturing

NAICS 3251 3259

European Union Classification of Economic Activities in the European Community (NACE)

NACE 24 Manufacture of Chemicals and Chemical Products

NAICS 24.1 24.7

UN International Standard Industrial Classification of all Economic Activities (ISIC)

ISIC Division 20 Manufacture of Chemicals and Chemical products

ISIC Group* 201 203

Source: Innovest. *Note: these categories are from the latest version of ISIC (ISIC Rev. 4), a revised structure approved by the UN Statistical Commission in 2006.

FIGURE 13 US Industrial Production according to chemical type (index where 2002 = 100)

2000 2001 2002 2003 2004 2005

Industrial Production (index where 2002=100) Total Business of Chemistry 96.0 94.3 100.0 99.7 102.8 102.5 Basic Chemicals 105.5 95.0 100.0 98.1 103.5 96.7 Inorganics 95.7 91.7 100.0 98.7 100.7 99.0 Alkalies and Chlorine 76.5 64.4 100.0 105.8 111.3 106.9 Industrial Gases 84.6 83.6 100.0 106.0 107.9 104.5 Inorganic Pigments 92.9 86.1 100.0 99.0 106.0 100.1 Acids 98.6 101.6 100.0 100.8 102.6 99.5 Other Inorganics 106.2 112.0 100.0 96.3 98.8 102.1 Petrochemicals & Derivatives 109.2 96.2 100.0 97.8 104.5 95.9 Organics 110.3 95.1 100.0 98.4 105.8 95.2 Synthetic Materials 108.0 97.5 100.0 97.2 102.9 96.8 Plastic Resins 105.6 94.5 100.0 96.1 102.2 95.9 Synthetic Rubber 105.1 95.4 100.0 94.9 100.8 95.1 Man-Made Fibers 109.5 89.0 100.1 104.3 112.3 99.9 Agricultural Chemicals 120.0 111.5 100.0 103.1 106.3 102.5


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Fertilizers 98.1 88.4 100.0 94.0 97.0 93.7 Crop Protection 110.3 102.6 100.0 110.1 113.4 118.3 Specialties 110.0 99.5 100.0 99.8 104.8 107.9 Coatings 101.0 98.8 100.0 96.4 101.3 102.9 Other Specialties 113.5 99.8 100.0 101.2 106.1 109.8 Pharmaceuticals 87.3 93.9 100.0 102.2 105.0 106.0 Consumer Products 87.8 89.5 100.0 94.6 93.2 98.9 Addenda Chemicals, excluding Pharmaceuticals 102.3 94.6 100.0 97.9 101.2 100.0

Basic & Specialty Chemicals 106.8 96.4 100.0 98.6 103.9 100.1 Adhesives & Sealants 109.6 107.6 100.0 105.2 122.3 124.5

Source: US Federal Reserve Board and ACC analysis. Notes: A measure of volume as calculated by ACC

NOTES ON SECTOR DEFINITIONS

The act of defining the sector in order to prioritize organizational efforts presents a complex challenge. We offer here a few informal parameters to aid in rationalizing a focus.

1. Both organic and inorganic chemicals are present on the US toxic release inventory. While those with little familiarity with chemistry might be inclined to associate a higher level of toxicity to inorganic chemistry, this would be incorrect. Note that benzene and polycyclical aromatic hydrycarbons are organic chemicals that have ecotoxicological risks associated with them.

2. Even relatively benign chemicals/materials in large amounts present risk

3. Volume of production is not necessarily a useful indicator. Increasingly, regulatory and activist entities have begun to concentrate on more esoteric chemicals. For example not all the chemicals listed on the OSPAR priority roster are high volume production items: http://www.ospar.org/eng/html/welcome.html.

4. Nanomaterials should be regarded as entirely new substances which do not interact with the environment according to macro scale physics. Nanoengineered particles have a higher surface to mass ratio. Hence volume is most certainly not the primary consideration in evaluating potential ecotoxicity issues for engineered nanomolecular structures. Particle size, chemical composition, and surface functionality are more pertinent aspects to consider.


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Global Chemical Sales (billions of dollars) 2005

United States 566.8Canada 49.3Mexico 35.5 North America 651.6

Brazil 78.0Other 90.9 Latin America 168.9

France 107.6Germany 151.9Italy 108.6United Kingdom 89.1Other Western Europe 233.5 Western Europe 690.7

Russia 39.2Other Central/Eastern Europe 51.1 Central/Eastern Europe 90.3

Africa & Middle East 107.8

Japan 253.2China 264.1India 67.2Korea 93.0Other East Asia 123.8Other Asia/Pacific 50.0 Asia/Pacific 851.3

Total World 2,560.6

3 Global Market and Production Global production of chemicals has increased from 1 million tons in 1930 to 400 million tons in 2005. There are approximately 100,000 types of chemicals produced today5 with 10,000 of them marketed in volumes greater than ten tons. The US is currently the top producer, producing 70,000 different chemical substances and generating $550 billion a year6.

Global production is highly concentrated geographically, with the EU, US, Japan, and China accounting for three quarters of global production. An estimated 30% of chemical production is traded across borders. Because of the diversity of products, many countries are both significant importers and exporters.

FIGURE 14 Global Chemical Sales (billions of dollars) 2005

5 5 US Department of Commerce, American Chemistry Council. Guide to the Business of Chemistry 2006. 6 ibid


29

FIGURE 15 Figure 15 Global Chemical Shipments, By Region Origin/Export 2005

Region ($ billion)

North America 628.7 United States 558.0 Canada 40.9 Mexico 29.9 Latin America 144.5 Brazil 69.5 Puerto Rico 45.0 Other Latin America 30.0 Western Europe 810.2 France 120.2 Germany 190.3 Italy 95.4 United Kingdom 96.8 Belgium 48.5 Ireland 43.0 Netherlands 49.8 Spain 53.8 Sweden 18.3 Switzerland 49.5 Other Western Europe 44.6 Central/Eastern Europe 88.4 Russia 40.9 Poland 12.7 Other Central & Eastern Europe 34.7 Africa & Middle East 90.6 South Africa 13.0 Israel 14.7 Saudi Arabia 13.8 Turkey 16.3 Other 32.7 Asia/Pacific 798.3 Japan 269.6 China 222.7 India 68.4 Korea 97.7 Indonesia 14.3 Singapore 18.4 Taiwan 46.0 Other East Asia 29.2 Australia 21.9 Other Asia/Pacific 9.9 Total World Shipments/Value of Output* 2,560.8

*Note: Includes pharmaceuticals Source: ABIQUIM, ANIQ, CCPA, CEFIC, JCIA, VCI, Bureau of the Census, Eurostat, Statistics Canada, United Nations, American Chemistry Council estimates


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FIGURE 16 Global Chemical Shipments by Industry

Product ($ billion)

Industrial Gases 48.9 Inorganics 106.1 Bulk Petrochemicals & Organics 450.7 Polymers, Synthetic Rubber & Man-Made Fibers 387.2 Basic Chemicals 992.9

Adhesives & Sealants 32.7 Coatings 111.6 Other Specialties 360.8 Specialties 505.1

Pharmaceuticals 648.4

Fertilizers 92.4 Crop Protection 38.8 Agricultural Chemicals 131.2

Consumer Products 283.1

Total World Shipments/Value of Output 2,560.7 Excluding Pharmaceuticals 1,912.3

Source: ACC estimates

FIGURE 17 Size of Regional Business of Chemistry

Source: The American Chemistry Council


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The global market is expected to continue to grow, mainly due to the expansion of the Asia-Pacific region, which could potentially take over the US and Europe as the main centers of production.

Global sales are estimated at $1.7 trillion for chemicals, and $330 billion for pharmaceuticals. Chemical companies around the world, however, are struggling to cope with the current high costs of raw materials and energy.

There are currently 120 chemical plants that cost $1 billion or more under construction; only one of those is being built in the US 7

7 Interview, Chemical Markeet Reporter . September 2006.


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REGIONAL TRENDS IN CHEMICAL PRODUCTION

Though long-term prospects for the US chemical industry are generally promising, foreign trade and investment have become increasingly important for US companies. Demand for chemicals in Asia, the Middle East, and Latin America continues to grow, and many US chemical companies are building production facilities overseas.

US Trade and Production

The chemical industry is the largest exporter in the US Historically, the industry has maintained trade surpluses, but since the early 2000s the trade balance has been negative. (This includes pharmaceuticals). This trade deficit can be attributed to the rise in energy costs, which reduce the competitiveness of the US industry and a decline in manufacturing in the US, as many producers shift to lower-cost regions such as Asia.

While US chemical exports rose in 2005, partly due to higher selling prices as a result of higher energy costs, imports of chemicals into the US continued to gain. Trade surpluses were maintained for organic chemicals and polymers, but trade deficits existed for specialty chemicals and pharmaceuticals. [S&P]

FIGURE 18 US Direct Investment Abroad (USDIA) and Foreign Direct Investment in the US (FDIUS) in the business of chemistry ($ million)

2000 2001 2002 2003 2004 2005

USDIA 81,727 79,186 82,543 91,435 99,435 109,354

FDIUS 120,413 128,630 123,341 136,466 138,081 151,624

Source: US Bureau of Economic Analysis

Lost Production in the US and other Developed Countries

While the US is still the largest exporter, the regions primacy in chemicals manufacture may be on the wane. High energy prices have caused the manufacture of semi-finished and finished goods to low cost centers such as China. This is resulting in so called lost manufacturing by the US Chemical sector. The estimated cumulative opportunity losses (based on trade losses) for the chemical sector over 10 years consist of $188bn in chemical sales, including $50bn in sales from the top


33

seven thermoplastic resins $40bn in capital expenditures in chemicals, including $5bn for new thermoplastics capacity $30bn in chemical research and development expenditures $43bn in US government tax revenue from chemical companies $3bn in charitable contributions from chemical companies and 157,000 chemical industry-related jobs8.

FIGURE 19 Capacity Utilization in the Business of Chemistry (% of capacity)

Source: Federal Reserve Board

Lost Manufacturing Effect on Petrochemicals: The US organic base chemicals industry is becoming increasingly global, as it is in Europe. More funds are being allocated for overseas expansion in petrochemicals than for domestic output. This is primarily attributable to the movement of commodity industrial consumers of plastics and fibers to regions where the cost of labor is low. Also, Middle East supply points give producers a net cost advantage in serving Asian markets.

Currently no new ethylene (the most important base organic chemical) plants are scheduled for completion in the continental US. This is in contrast with Europe, where there are a few ethylene expansions planned or in progress in the next two-to-four

8 American Chemistry Council ACC, Innovest research

Capacity Utilization (% of capacity)

72%

74%

76%

78%

80%

82%

84%

86%

1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

Capacity Utilization (% of capacity)


34

years.9

By 2015, about 11m tons of the top seven thermoplastics will be imported instead of produced locally.

FIGURE 20 Lost Manufacturing in the United States

Source: Chemical Market Reporter

China

Is it all about China and to a lesser extent India?

China led the global growth in chemical demand over the past two years. Western multinationals are currently shifting chemical production to China, and Chinese companies are increasing their capacity to try to meet the demand of the burgeoning Chinese based market for chemicals for production of consumer goods, industrial and agricultural chemicals. The table below reflects the level of production assets for reporting firms in the Innovest analytical set. China represents the majority portion of these assets for most of these firms.

9 Lost Manufacturing.Chemical Market Reporter. ICIS Chemical Business America. 6 November 2006.

Production vs. Consumption (billions USD)

0

1000

2000

3000

4000

5000

6000

2004 2015

Production Consumption

Chemistry Gained (billions USD)

2004

2015

-25

-20

-15

-10

-5

0

5

10

2004 2015

Chemistry (billions USD)

Production vs. Consumption (billions USD)

0

1000

2000

3000

4000

5000

6000

2004 2015

Production Consumption

Chemistry Gained (billions USD)

2004

2015

-25

-20

-15

-10

-5

0

5

10

2004 2015

Chemistry (billions USD)


35

FIGURE 21 Percentage of Production Assets in Emerging Markets Global Chemicals Sector 2005/06

Source: Innovest, Thomson/FirstCall Note: Companies do not specifically report China sales in a useable data format

In 2005, China became the third largest producer of chemicals, after the US and Japan.

Nevertheless, China is expected to continue to be a major market for chemicals produced by other countries. According to KPMG, even with a huge amount of new capacity planned for the next 5-10 years, China will continue to be dependent on imports of such bulk goods for the foreseeable future. The American Chemistry Council (ACC) forecasts that over the next 10 years, annual output growth of Chinas chemical industry will average around 10%.

Leading Chinese chemical companies include Sinopec, PetroChina, Sinochem, China National Offshore Oil Corp. (CNOOC), and China National Chemical Chemical Corp. (ChemChina).

The leaders in the sector, Sinopec and PetroChina, are moving forward to expand their olefins and derivatives capacity. This is expected to double Chinas ethylene capacity, though China will still continue to import large amounts of ethylene and derivatives. Half of the growth in new ethylene capacity in the next five years will be in the Middle East and one-third will be in Asia, Mansour Al-Kharboush, vice president, shared services, and chairman of Sabic India said at the 8th Indian

Percentage of production assets in emerging markets

0% 5% 10% 15% 20% 25% 30% 35%

Nitto Denko Corp.Yara International ASA

International Flavours & FragrancesSyngenta AG

Toray Industries IncUBE Industries

Hitachi Chemical Company LimitedImperial Chemical Industries PLC

Bayer AGMitsubishi Rayon Company Limited

Kansai Paint Company LimitedPPG Industries Inc

Novozymes A/SDaicel Chemical Industries Limited

Mitsui ChemicalsSumitomo Chemical Company Limited

Monsanto CompanyLyondell Chemical Company

ClariantKaneka Corporation

Potash Sask IncSigma Aldrich Corp.

Mitsubishi Chemical Holdings Corp.Dainippon Ink & Chemicals

Praxair IncShin-Etsu Chemical Company Limited

Akzo Nobel NVGivaudan

Tosoh CorporationAgrium Inc

Dow Chemicals CompanyBASF AG

Lonza GroupCelanese AG

Koninklijke DSMRohm & Haas Company

Zeon Corp.Kuraray Company Limited

Methanex Corp.Du Pont EI De Nemours

Nevertheless, China is expected to continue to be a major market for chemicals produced by other countries.


36

Petrochem conference in Mumbai. "By 2010, ethylene production in Iran and the Gulf Cooperation Council (GCC) countries is estimated to account for about 20% of the global capacity," Al-Kharboush said10.

While several joint ventures in ethylene have been commissioned by multinationals such as Shell, BASF, and BP, it is expected that future projects will eventually rely less upon foreign investment. According to KPMG, production of bulk commodities will be more difficult for foreign companies. However, foreign investment is expected to play a large role in the specialty chemicals sector, since the Chinese government is initiating a new focus on innovation as opposed to industrial production. China appears to be in the midst of a shift in emphasis from manufacturing to innovation. In June 2006, the Chinese government unveiled an ambitious long-term plan to move from a manufacturing economy to an innovation-based one. China is set to boost R&D expenditure to levels comparable to that of the US and Japan. Currently, China devotes only 1.2% of its GDP to R&D spending, and the government has announced its intention to boost that figure to 2% by the end of the decade and 2.5% by 2020. By then, China will be spending $110bn/year on R&D, putting the country at a level comparable to the US and Japan. According to an executive summary conducted by the Economist Intelligence Unit, an increasing number of companies are viewing the Chinese Government's active support for R&D as China 's greatest asset. In addition to government support, the low-cost environment and skilled researchers are what make China an R&D destination for multinationals. However, despite these incentives intellectual property concerns persist. China has yet to tackle the copycat culture and develops its financial system, two major obstacles that may hinder the shift.

While we state that China will continue to be an importer of chemicals, Innovest analysis shows that production of certain chemicals is already at capacity in China and there is even overcapacity in some regions for specific items such as PVC and related products. The Chinese government has begun implementing a quota system in certain regions.

To counter the high costs of oil and gas, steps have been taken to develop chemicals from coal Chinas cheapest and most abundant natural resource. The government is encouraging the development of new technologies to make this a cleaner, more energy efficient process.

Examples of current global investment in China:

GE Plastics signed a deal (summer 2006) with PetroChina to create a world-scale polycarbonate (PC) resin manufacturing joint venture.

10 Chemical Market Reporter News Brief, 16 November 2006

It is expected that future projects will eventually rely less upon foreign investment.


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DuPont reports double-digit growth in China and plans to continue investment. According DuPonts head of China operations, China is our number one focus in the world for investment.

Degussa recently opened a polyesters and colorant plant at the Shangai Chemical Industry Park.

Key issues for global chemical companies working in China NEW ENVIRONMENTAL REGULATIONS

The mad rush to China may not be a winning proposition for all companies, and in fact, is turning out to be more costly than expected. Several firms are now facing increased operating costs due to new regulatory developments taking place in China, which is laying the foundation for increased environmental oversight for domestic and foreign-owned firms. This is resulting in regional energy use and production targets, and other grand initiatives. Several companies are already feeling the increased intensity. For example, the commodity firm Mitsui was among the first targets of dioxin-related cleanup in China.

PVC

In order to head off energy use and environmental issues, in June 2006, the Chinese State Environment Protection Administration (SEPA) proposed that the Inner Mongolia province should cut its targets of PVC production to 5 million tons per each. Targets were also set for coal and energy generation. There is the potential for this to impact other regions, considering that the Chinese government has committed to invest more than $85 billion to improve the environment by promoting clean energy sources.

WATER TREATMENT

With approximately 90% of China's cities and 75% of its lakes suffering from some degree of water pollution, a multitude of chemical companies are flocking to provide water treatment chemicals and services in various forms. Market driving forces include the recently issued governmental five-year plan, which aims to have 60% sewage treatment in bigger cities by 2010. Additionally, the 2008 Olympic Games in Beijing and the 2010 Shanghai World Expo pose as pressing incentives to improve environmental conditions in China. Chinese demand for water treatment products is currently expected to increase by about 14% per year. Large players in Chinas water treatment market include Dow and Ciba Specialty Chemicals. Dow recently expanded into the market with its acquisition of Zhejiang Omex Environmental Engineering (OEE), a company which has provided design engineering and installation for high-purity water facilities throughout China since 1995.


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India

India is borrowing the special economic zone (SEZ) concept from China in order to boost business in areas such as oil refining, petrochemicals and textiles. Gujarat, in the west, has been one of the most active areas in attracting foreign and local companies. It claims to have 68% of the country's petroleum, chemical and pharmaceutical production, 21% of India's chemical output, and the highest share in polymer production11.

Public interest groups and other organizations are concerned about the sovereignty of the SEZ model. Business World recently reported that buried in the SEZ Act of 2005 is a stipulation that zones are exempt from any central government act or other regulations. Plus, industries in SEZs are under no obligation to conduct environmental-impact assessments, or hold environmental public hearings.

Middle East

According to Innovest sources, the Middle East is slowly emerging as a chemical production leader because of competitively priced feedstock, and its close proximity to growth markets such as India and China. Most of the production is petrochemicals. For example, in 2005, the UAE's petrochemical industry grew to account for 6% of the total GCC production.Among GCC countries, Saudi Arabia accounted for 76% of the total regional petrochemical production, followed by Qatar (11%), Kuwait (6%) the UAE (6%), and Bahrain (1%)12.

At a recent industry conference leading analysts urged chemicals producers in the region to begin developing beyond basic petrochemicals production. More complex chemistries are needed in order to serve nearby markets. ICIS Chemicals Business America states that approximately 75% of petrochemical companies in Dubai were engaged in manufacturing other chemicals, which include pesticides, agrochemical products, paints, varnishes, pharmaceuticals, medicinal chemicals, detergent and cosmetics this year13.

11 Kovac, Matt. View from India News and Analysis. Chemical Market Reporter. 6 November 2006. 12 Anuradha Rao.Petchems dominate Middle East investment. ICIS Chemical Business America . 18 December, 2006 13 Anuradha Rao.Petchems dominate Middle East investment. ICIS Chemical Business America . 18 December, 2006


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Organic chemicals that are manufactured in, or imported into, the United States in amounts equal to or exceeding 10,000 pounds per year are subject to reporting under the TSCA IUR. Reporting is required every four years.

The HPV Challenge Program Chemical List consists of all the HPV chemicals reported during the 1990 IUR reporting year. Inorganic chemicals and polymers, except in special circumstances, were not subject to the IUR reporting requirements, although a number were reported in error. The HPV Challenge Program Chemical List contains about 2,800 chemicals.

PROFITS

Profits: Where does the chemical industry make the most money? Which products have the highest profit margins? Where do they see high profit growth?

Chemicals and pharmaceuticals are fundamental to the all manufacturing industries. A breakdown of the US chemical business illustrates the range of industries to which the chemical sector provides its products.


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FIGURE 22 US Business of Chemistry, 2005 ($ billions)

Source: US Census Bureau data and American Chemistry Council (ACC) analysis

Specialty chemicals, including pharmaceuticals, are the most profitable segment of the industry. Commodity pricing is also a factor in evaluating high profit centers.

FIGURE 23 Global Chemicals Market Segmentation: % Share by Value, 2004

Category % Share

Base Chemicals 39% Pharmaceuticals 26% Specialty & Fine Chemicals 23% Consumer Chemicals 12%

Source: Datamonitor

The rise in prices was a key factor driving increases in the value of shipments for 2005. The rise in shipments translated into an increase in company sales in most cases, and this, in addition to cost-cutting at many companies, led to higher earnings and profitability.


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MANUFACTURING

Industrial customers are major users of chemicals, and the strength of the manufacturing sector has a significant impact on the chemical sector. About half of the output of the chemical industry goes to US manufacturing companies, to be used as raw material in production processes. According to S&P, the long-term shift of production companies from the US to lower-cost regions such as Asia will continue to negatively impact the US chemical industry.

CONSTRUCTION

The residential construction market is a major consumer of chemicals. The construction industry is responsible for 3.4% of all chemical purchases in the US, making it the fourth largest consumer of the US business of chemistry. Chemicals comprise approximately 17% of all materials used in new construction. Home construction and buying consumes synthetic materials such as pipes and siding, manufactured from plastics. Construction stimulates demand for appliances, carpeting, furniture, and paints also produced from chemicals. The strength of the construction industry directly impacts the strength of the chemical industry.

AUTOMOBILES

Car manufacturing consumes a significant amount of chemical products in the form of plastics, rubber, fibers, and paint. Every automobile contains over $2,000 worth of chemical processing and products. Most of the major Diversified chemical firms serve the automotive sector in the areas of specialized coatings and plastics. In the case of firms like Akzo Nobel and DuPont, the automotive sector is the primary client for those divisions.

FORCES FOR CHANGE IN THE INDUSTRY:

Forces for change in the industry. Trends in the chemical industry include consolidation, production shifting away from the US, Europe, and Japan to other regions, increasing prices for feedstocks, increasing regulation, and growing demand for green chemicals.


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What are the significant forces shaping the chemical industry today and how can they be harnessed to move the industry to green chemistry?

Energy

The price of crude oil and particularly natural gas have always represented a material concern for the sector but last years volatility pushed the envelope for several of the companies covered in this analysis. Elevated energy prices have contributed to layoffs and diminished profits. High energy prices not only increase the cost of operation but generally slow down economies. This issue is so critical, that the CEOs of several of the major players in the industry were collectively imploring the Bush Administration to adopt an Energy Policy last year that would allow sector leaders to provide investors with some assurances about the future profit potential of chemicals production. Moreover, the companies themselves are increasingly aware of the importance of developing environmentally sound capacity to deal with energy price fluctuations over the long-term.

In the US, the chemical industry accounts for almost 7% of total energy use. Major energy sources are petroleum and natural gas, and about 50% of total energy consumption goes to raw material use. According to the ACC, in 2005 the US chemical industry spent $63 billion on fuel, energy, and feedstock (up from $51 billion in 2004).

In Europe, members of the European Chemical Industry Council account for approximately 12% of all EU energy demand. Over the past decade energy use for the chemical sector as a unit of production has been steadily increasing; however, the carbon intensity of energy use is generally declining.

The International Energy Agency estimates that energy related costs may represent approximately 7-15% of net income for a given chemical company depending on the specific nature of its operations or in some special cases, accounting for up to 85% of production costs.

Energy use per unit of production was on the rise for most companies in the sector. The American Chemistry Council predicts that feedstock unit costs and other energy costs will remain at high levels through 2007. Companies face a 12.4% increase in feedstock costs and operating energy costs will increase by 24.9%. Dows energy efficiency target for 2005 was the reduction of 290 trillion BTUs equivalent to Californias annual residential electricity use. DuPont has estimated its fuel savings at more than $2 billion since 1990 due to conservation and improved product yield. Twenty percent of Showa Denkos energy mix is derived from hydroelectric power. In general, many of the chemical companies we track are having difficulty meeting their


43

annual energy use reduction targets and havent been meeting them for several years.

Companies typically rely on hedging and fuel switching in order to adjust for volatility. These are near-term strategies for managing exposure to energy risk in the sector. We wanted to know whether companies find it economically efficient to plan for longer term scenarios given a certain intensity of process. We selected 17 companies that we categorized as having high energy intensity ratings. They all responded that they do indeed find it necessary to plan for the long term which is why some of them invest in on-sight co-generation for example. Approximately 9 companies include renewable energy technology into their long-term energy risk management strategies. Japanese firms typically apply more quantitative rigor in demonstrating to shareholders the value from investing in process enhancements. For example, Toray states that it reduced energy costs by 658 million ($5.7m USD) in 2004. Hitachi saved 290 million ($2.5m USD) in 2005.

FIGURE 24 Energy Performance of Select Companies, 2005

Note: (Score 10= good performance). Scores are an aggregate of quantitative and qualitative factors including energy related greenhouse gas emissions normalized by sales among other measures. Source: Innovest

Globalization

World trade is an important element of globalization. Historically, many of the industrialized developed nations have maintained trade surpluses in chemicals.

Total Energy Related Score (max 10)

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Western Europe is by far the largest exporting block; Japan maintains a modest surplus as well. Asia-Pacific runs a large deficit in chemistry trade, and has been traditionally followed by Latin America, Africa, and Central & Eastern Europe. A major development over the last five years has been the erosion of North Americas trade surplus to what is now the third largest deficit position among regions. According to S&P, world trade in chemicals (exports and imports among countries) grew more than twice as fast as global output during the 1990s. More than a 1/3 of total global production is currently traded internationally.

In the US, chemical sales are expected to grow about the same rate of the domestic GDP. Foreign trade and investment are becoming increasingly important for the US industry as demand from chemical markets outside the US and Europe grows, particularly in Asia.

Many US and European companies are investing in building new production sites closer to the growing emerging markets. In 2004, the US chemical industry invested about $10 billion abroad (about double the level of ten years earlier). In addition, many of the industrys US-based custumers are moving their operations overseas where costs of production are lower.

Elevated feedstock prices and rapid growth of Asian markets have caused many companies to expand production to China, Malaysia, Singapore and other low-cost locations. This has implications for a variety of atypical operational and business factors that can impact performance. For example, a tightening of environmental regulations coming online in China may increase production costs in a market previously considered facile on such requirements.

US companies have recently invested in, or are seriously considering, joint-ventures throughout the world. Major projects include:

Dow - Kuwait, Oman, Malaysia, Thailand

Exxon Mobil - Singapore, China, Qatar

Chevron Phillips Chemical - China, Qatar, Saudi Arabia, China, Singapore

Consolidation

Sector experts are saying that the increase in mergers that began in 2006 is likely to continue in 2007. Apparently the sector is undergoing its third major surge in M&A activity similar to those in the late 1980s and in the late 1990s. Moreover this season may produce a record number of transactions . Hedge funds seem to be driving a lot of the activity. The positive outlook for the economy may be the reason that so many deals are going forward. Single digit growth for most of these companies means that mergers and acquisitions are often the only way to improve those numbers.


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Examples of mergers (and divestments include) BASF, Ashland, Eastman, Chemtura and others.

Innovation

Much has recently been made about the correlation between sales and innovation for major industrial sectors, particularly the chemicals sector. Cleantech and green chemistry appear to be the new buzzwords in innovation for the sector. At least 12 out of 17 Diversified firms, approximately 10 Specialty firms and 9 of the Commodities companies are apparently launching cleantech/green chemistry strategies or are at least stating interest. Innovest finds that the build up in interest has been generating over the past few years but seems to have picked up momentum in 2005.

Estimated global sales of renewable-based/biotech-based chemicals in 2005 are $98 billion or 7% of global chemical sales. Biofuels take off with Ag/Chemical and Biotech players scrambling to take advantage of $3 billion worth of US Federal funding for research for bio-energy related R&D and commercialization.

Significant initial investments

Regardless of whether its biofuels or alternative plasticizers, there is not always first mover advantage associated with this type of innovation and investments are considerable.

Profit Potential

Analysts at Mckinsey and Company place chemicals based on renewable feedstock or manufactured via fermentation or enzymatic processes at 10% of the total global chemical sales valued at $159 billion by 2010.

The market for environmental catalysts is projected to grow from $4.2 billion in 2004 to $9.1 billion in 2009.

DuPont expects to add $6 billion to company sales by 2015 based on cleantech and green chemistry innovations.

For further information about the profit and investment prospects of these new technology platforms, please see Innovests 2006 Diversified Chemicals Sector Report. Please Contact Heather Langsner at [email protected] to acquire a copy of the report.


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Investment Dollars

Innovest has been informing investors for several years that chemical product liability is likely to be a driver of event risk for investors going forward. Lyondell (LYO: NYSE) and DuPont (DD: NYSE) are useful examples. Interestingly, this has been a record-breaking year for shareholder resolutions pertaining to toxics in products. The movement has culminated this May in a joint statement by seventeen investing organizations collectively representing more than $22 billion in assets under management.

The initiative calls for other investors to join with them in supporting shareholder resolutions seeking better disclosure regarding capital at risk pertaining to toxics in products. Note that the Carbon Disclosure Project started three years ago at a similarly low level and now represents $31 trillion in assets under management. The Investor Environmental Health Network (IEHN) also wants companies to explain the opportunities for moving to safer alternatives. Innovest is the only investment research firm that currently identifies chemical product risk prior to incident. Conventional analysis does not consider this in valuation.


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Innovation

What sectors drive innovation in the chemical industry? e.g., pharmaceutical industry? What other sectors?

Major areas of R&D interest, as well as technological developments achieving rapid diffusion in recent years include:

Biotechnology in chemical production New materials for construction applications

Metallocene & other single-site catalysis Advanced composites New inorganic chemistry Other specialty polymers

Powder coatings, radiation-cured coatings,

and water-based coatings

New fibers (polymethylene terephthlate,

corn-based, etc.)

Sustainable chemistry Smart plastics and fibers

New solvent cleaning technologies Chemicals and materials for microelectronics

Combinatorial technology (molecular modeling,

integration of artificial intelligence, etc.)

Advanced materials for high-perform

Nanomaterials Bioprocesses & biocatalysts

Direct oxidation of alkanes Electro-optic & conductive polymers


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Patents

FIGURE 25 Patents Granted by Segment and Nation

Patents Granted 1995 1996 1997 1998 1999 2000 2001 2002 2003

101,419

109,645

111,984

147,518

153,486

157,494

166,037

167,333

169,028 Total Patents Granted (All Technologies)

13.4% 13.4% 15.3% 13.9% 13.6% 12.3% 12.6% 12.5% 11.3% Total Business of Chemistry 13,563 14,645 17,188 20,507 20,829 19,434 20,871 20,945 19,089 By Business Segment Pharmaceuticals 3,011 3,773 5,284 6,476 6,658 6,085 6,666 6,514 6,013 Chemicals, excluding Pharmaceuticals 10,552 10,872 11,904 14,031 14,171 13,349 14,205 14,431 13,076 Agricultural Chemicals 1,861 2,156 2,759 2,885 3,008 2,880 3,103 3,168 2,857 Consumer Products 718 747 858 1,081 1,237 1,025 1,111 1,207 1,073 Basis Chemicals & Specialties 7,973 7,969 8,287 10,065 9,926 9,444 9,991 10,056 9,146 Basic Chemicals 6,546 6,399 6,792 8,277 8,075 7,609 8,195 8,413 7,356 Inorganic Chemicals 896 849 813 1,015 1,064 1,041 1,006 1,021 1,053 Bulk Petrochemicals & Organic Intermediates 4,230 4,187 4,551 5,698 5,632 5,041 5,343 5,637 4,652

Polymers, Synthetic Rubber & Man-Made Fibers 1,420 1,363 1,428 1,564 1,379 1,527 1,846 1,755 1,651

Specialties 1,427 1,570 1,495 1,788 1,851 1,835 1,796 1,643 1,790 Coatings 548 548 507 592 681 595 606 606 591 Other Specialties 879 1,022 988 1,196 1,170 1,240 1,190 1,037 1,199 By Nation United States 7,076 8,006 9,633 11,287 11,552 10,578 11,056 11,161 10,171 Japan 2,268 2,196 2,312 2,834 2,692 2,533 2,837 2,723 2,436 Germany 1,428 1,437 1,581 1,854 1,771 1,789 1,968 1,959 1,792 France 594 609 767 897 902 844 952 929 860 United Kingdom 550 522 696 879 883 876 901 839 738 Canada 226 275 323 446 504 471 497 504 424 Italy 257 278 292 317 319 316 309 310 275 South Korea 83 98 99 130 175 186 215 241 266 Netherlands 107 110 152 230 227 230 242 234 240 Switzerland 264 272 297 291 311 254 307 299 233 Belgium/Luxembourg 111 139 168 213 216 199 220 264 200 India 20 18 28 56 75 86 118 175 200 Sweden 76 93 124 135 161 144 166 178 181 Israel 52 84 81 112 122 114 111 155 171 Denmark 69 72 117 159 185 166 180 139 170


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Australia 58 62 86 132 135 105 154 137 102 Taiwan 36 49 55 65 94 79 112 112 95 Other 324 374 432 535 599 543 638 698 630

Source: US Patent and Trademark Office

FIGURE 26 Basic and Specialty Chemical Revenues from New Products (as % of Revenues) ESTIMATED

1994 1999 2002 2003 2004 2005

All 13% 20% 13% 11% 14% 13% Basic 12% 15% 13% 3% 16% 14% Specialty 15% 23% 15% 15% 17% 13% Small 10% 15% 11% 10% 15% 31% Mid 13% 17% 22% 11% 17% 13% Large 13% 20% 11% 16% 16% 14%

Source: ACC


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4 The Corporations

The following is a list of overarching themes that stand out as being pertinent to an understanding of individual chemical companies and the sector in general.

Marginal business The most inherent and fundamental characteristic to understand about the industry is the extremely tight margins within which these companies operate. This stems from two factors:

Downward price pressure: Even producers of the more esoteric small batch specialty products eventually must face the fact that they will experience increasingly tight markets as competition expands. The extent of this issue is extreme to the extent that price fixing has become rampant throughout the industry.

Raw material price increases: Price volatility can have dramatic affects within a given quarter.

Equity stakeholders dominate The chemicals sector is largely financed through equity as opposed to other forms of corporate financing. As such, the combination of tight markets and volatility in the price of key industrial inputs means that companies are often announcing a round of cost cutbacks in order to meet quarterly share price projections. As discussed later in this report, capital upgrade expenditures are often at the top of the list for rapid cutbacks. Our analysis reveals a potential connection between delayed capital expenditures and facility integrity and safety problems. For further information on this topic please see our report on The Implications of Enterprise Risk for the Chemical Sector 2007. Please contact Heather Langsner at [email protected] for a copy of the report.

Complex footprint There are far more chemical companies than are typically assumed. In addition to major companies such as BASF, Dow, and DuPont, there are thousands of small and medium-sized companies operating privately around the world. Moreover, the large capitalization firms may have joint venture holdings with multiple small players. Sometimes the level of ownership is quite small. This may dictate the level and quality of enterprise risk management for these smaller entities. In the event of an incident, the relatively small holding by the large cap parent might serve as an easy excuse to avoid liability.


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Cyclical business The performance of the aggregated chemicals sector is largely tied to general economic cycles. Further, specific products are inherently tied to the fluctuations of specific markets such as automotive, housing, etc. Changes occurring in those sectors have a large effect on product formulation and product sales.

Declines in housing starts and a potential overall slump in the economy are predicted to cause merely a slight reduction in demand as opposed to an abrupt downturn. Expansions are lasting longer and GDP is only expected to drop to 2.6% this year before returning to 3.4% again in 2008 according to top industry economists. End markets such as textiles, packaging and electronics and other goods are experiencing growth. However, note our projections regarding the reduction in demand for PVC applications in the 2006 Chemicals Sector Report. Many of our Diversified chemicals firms are reporting favorable earnings this quarter and in Duponts case, there is reason to believe that management is purposefully being overly cautious about its 2007 1Q estimates.

Who are the major global producers of chemica

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